Another US Current Account Beat-Up

You can’t help but be suspicious of a story reporting on a speech by Australian Treasury Secretary Ken Henry with the headline ‘US deficits risk crash: Treasury.’ My suspicions deepened when the report contained only two direct quotes from Henry.

Henry’s actual speech is nothing exceptional and does not use the word ‘crash’ once. The Australian Treasury has in fact argued persuasively for the sustainability of large US current account deficits.

Australia routinely experiences cyclical deteriorations in its current account balance as a share of GDP that make the current US deficit look small by comparison. The Australian Treasury has long been converted to the consenting adults view of the current account. If it views the US differently, it is because of the public sector contribution to the US deficit, which is a fiscal policy issue, not an external imbalance problem.

Next week, Australia is likely to report a monster Q4 current account deficit. I will be running a competition for the most melodramatic and silly reporting of, or commentary on, this number. Send me your sightings by email or post them in comments.

Henry was not setting out to ring the alarm on the “coming crash”, and would probably have been surprised—pleasantly or otherwise—to read words on the front of a national newspaper that would inevitably be dished up to the Prime Minister and/or the Treasurer.

House Price Inflation without the Froth

When confronted with asset price inflation, many economists are all too ready to declare a ‘bubble,’ which saves them the bother of actually having to think seriously about the economics underlying asset prices. Fortunately, the BoE MPC’s Kate Barker is not one of these people. In a speech to the IEA, she carefully examines the relevant fundamentals and puts them in a broader context, noting:

In previous speeches I and other MPC members have set out why it is generally undesirable to target asset prices when setting interest rates – particular reasons being the wide range of uncertainty around the equilibrium for any asset price, and the dangers to credibility of diverting policy from the goal of achieving the Government’s inflation target.

While RBA Governor Macfarlane has also highlighted the dangers of using monetary policy to target asset prices, the RBA’s public comments on house prices and private sector credit growth have diverted attention from its inflation target and confused the public and markets. The RBA’s mistake was to express a strong (and arguably mistaken) view on house prices and private sector credit growth, but without being willing to actually take responsibility for outcomes in relation to these variables. This was the right policy choice, but calls for a more agnostic public stance on these issues so as to keep the inflation target centre stage.

Markets in Everything: The PAM Rides Again

Remember the Pentagon’s ill-fated Policy Analysis Market? Intrade is now offering a contract on the timing of US air strikes against states sponsoring terrorism:

The contract will be expired at 100 if the USA officially launch and execute an overt Air Strike against land facilities in any of the listed countries on or before June 30, 2005.

The countries involved and currently listed as States known to sponsor terrorism are: Cuba, Iran, Libya, North Korea, Sudan & Syria. Only these six countries count for expiry purposes. An overt Air Strike against a land facility will be defined as an air attack officially announced by the Pentagon or the US Department of Defense. It will not include any covert operations, accidental border clash, etc. The contract will be paused and subsequently expired once such an attack has been reported to have taken place against a land facility in any of the named countries.

The contract has yet to trade, but market depth is pointing to an implied probability in the low teens. This contract would have been more informative if it were based on individual countries, rather than such a disparate group.

More on Pop Austrianism and the Business Cycle

A key element of the pop Austrian critique of contemporary monetary policy is that the inherent unevenness of the process by which newly created base money and inflation work their way through an economy creates a structure of production that a free market economy would not otherwise support (the Ludwig von Mises Institute has plenty of examples of this sort of claim). In the Austrian view, growth in broad money, credit aggregates and even asset prices is built on a house of cards: fiat money leveraged through fractional reserve banking. Even those Austrians who accept fractional reserve banking consequently see almost any central bank policy action as inherently destabilising.

A major problem with this view is that there is no necessary connection between interest rate targeting by central banks and the money base (although in practice they are usually closely linked by the operating procedures currently favoured by monetary authorities). In principle at least, we could have a market-determined money supply and even non-centralised clearing of overnight inter-bank lending and yet still have a central bank successfully targeting an official short term interest rate through its willingness to buy and sell relevant instruments at given prices. Unless we define free banking as the complete absence of a central bank, there is no reason why the two institutions could not co-exist.

The US Net IIP: Non-Hysterical Version

Much of the hysteria surrounding the US current account deficit reflects a basic lack of faith in US institutions and growth prospects. David Levey and Stuart Brown have a refreshingly different perspective:

While the NIIP will continue to grow for many years to come, future dollar depreciation and market adjustments in interest rates and asset prices will mean that its increase will be far less dramatic than many fear. Moreover, focusing exclusively on the NIIP obscures the United States’ institutional, technological and demographic advantages. The classic doomsayer argument - that growing foreign indebtedness results from too little savings by Americans - neglects the fact that savings and investment are seriously undervalued in U.S. economic accounts. When you include capital gains, 401(k) retirement plans, and home values, U.S. domestic saving is around 20 percent of GDP, the same as in most other developed economies. And when you consider “intangible” investment (like new-product development and design experimentation) as part of total, the supposed increase in consumer
spending as a share of GDP turns out to be a statistical artifact.

Indeed, much of the explanation for chronic current account deficits relates to the U.S. economy’s strong fundamentals, not fatal structural flaws.

The country with the world’s strongest external investment position is Japan, which achieved this dubious distinction by trashing its potential growth rate and the returns on domestic investment through state-sponsored forced saving and the overcapitalistion of its economy.

The Anglo-American Model Delivers

I recently came across a forsaken copy of Peter Brain’s (1999) Beyond Meltdown in a second-hand bookstore. In the course of a diatribe against ‘neo-liberal’ economics and the ‘American’ economic model in Australia, Brain forecast that the Australian economy would enter a prolonged stagnation in the wake of the 2000 Olympics, during which the unemployment rate would return to the double-digit figures seen during the last recession in the early 1990s.

Instead, the Australian economy has gone from strength to strength, with the unemployment rate hitting multi-decade lows, precisely because it has generally avoided the policy prescriptions favoured by the likes of Brain.

The Anglo-American economies currently look a whole lot better than those countries that have followed less liberal policy prescriptions. Japan has just gone back into recession for the third time since 1998. Germany is just shy of its third recession in four years.

Meanwhile, the UK, Australia and NZ are all enjoying their lowest unemployment rates in decades. This is particularly telling, since the ‘neo-liberal’ policies supposedly favoured by the Anglo-American economies are often stereotyped as anti-employment. The evidence suggests otherwise.

Of course, there is no reason why the Anglo-American economies cannot also experience a downturn in the near future, but even in recession, they will fare much better than those economies outside the Anglo-American bloc, due to their greater commitment to liberal policy prescriptions.

UPDATE: My Google ad strip is now rather amusingly showing “Discount GDP Forecasts: New and Used GDP Forecasts.” It is of course an ad for Ebay, not Peter’s book.

The House Economics Committee Gets a New Chair

Those of us who argue for greater central bank transparency can only cringe when the Reserve Bank Governor fronts the House Economics Committee. You have to admire the patience and politeness Governor Macfarlane displays in the face of the Committee’s woeful displays of economic illiteracy and ham-fisted attempts at point scoring.

Things are not going to get much better under the Committee’s new chair, Bruce Baird, who has rather helpfully put out a press release alerting us to what is on the Committee’s collective mind. Baird says:

I’m also interested in what incentives the Reserve believes are needed to encourage greater private investment and whether there should be a diversion away from investing in private housing.

This is of course well outside the Governor’s mandate and, dare I suggest, also outside the realm of legitimate public policy concern. The implication that investment in housing is excessive is particularly galling coming from people whose own homes are, at a wild guess, a cut above average. It is fine for them to invest in housing, but a dangerous ‘bubble’ when everyone else gets in on the act.

Baird is also a coordinator of the informal government committee, the Friends of Tourism Group. This sits rather uneasily with his current efforts to deny Singapore Airlines access to the Australia-US route in order to protect Qantas jobs in his electorate, which includes Sydney Airport. The sort of ‘friend’ tourism could do without.

Myth Busting the House Price ‘Bubble’

The prevailing mythology surrounding the Australian economy in recent years is that economic growth has been driven by consumption, which in turn has been driven by a house price boom. It is true that consumption has largely accounted for headline GDP growth in recent quarters. But as John Edwards has pointed out, consumption and national saving as a share of GDP have been remarkably steady. What has changed is the investment share of GDP (including dwelling investment), which in real terms is currently the strongest it has been during the post-war period. In this context, the deterioration in the current account balance is a cause for celebration, because it represents an investment boom, not a collapse in saving.

In the chart below, I have shown real Sydney house prices and GDP as percentage deviations from their linear trends. It is remarkable the extent to which the cycle in real house prices has lagged the business cycle. GDP has been consistently at or above trend since the end of 1997, but real house prices in Sydney only exceeded their own trend from the beginning of 2002, after a decade of below trend growth. The chart puts the supposed ‘bubble’ in Sydney house prices in cyclical perspective. Of course, some would argue that the secular trend in house prices is itself a bubble and one can take issue with the detrending methodology, but the notion that house prices have been leading the economy looks rather strained.

If there is anything to the stylised Australian house price cycle (turn of the decade booms, followed by middle of the decade slumps), then the cycle in house prices should bottom at the end of 2006 (as it did in 1986 and 1996), but only after the economy has already slowed for reasons that have little to do with house prices.

Supply-Side Constraints and House Prices

The Economist finally has something to sensible to say on house prices, reporting on research into the effects of supply-side constraints on house prices in US cities. There is hope for The Economist yet! The original paper is here.

Meanwhile, David Smith highlights the sorry record of house price crash predictions in the UK:

The first housing-crash story I could find in the present cycle came in 1996, when one Bob Beckman predicted a 20-year fall in prices. There was another batch in 1997, when the fear was that Labour’s election would hit house prices hard.

In 1998 and 1999, when the stock market was booming, there was a steady trickle of housing-crash predictions, building further when the stock-market boom turned to bust in 2000. The September 11 attacks on America persuaded many that housing was about to take a dive and, in the three years since, talk of a housing crash has built up to a crescendo.

David Smith’s skepticism is refreshing. It is interesting that the debate about house prices in the US, Australia and the UK is very similar, yet so many commentators remain wedded to country-specific explanations for what is clearly a global price shock to this asset class.

Throw the FIRB on the Bonfire

The FT calls for a Ludwig Erhard-style bonfire of Australian controls, with the FIRB on top of pyre:

the Financial Times called on the Australian Government to overhaul its foreign investment regime and scrap the body that implements it, the Foreign Investment Review Board.

It said the usual suspects, notably “businesses that would find it convenient to have the [WMC] takeover stopped” had lobbied against Xstrata being cleared to have a tilt at WMC, but the real problem was Australia’s foreign investment screening system, which was “a protectionist relic” that sat badly with the Australian Government’s free market principles.

Other nations, including the United States, also screened incoming investments “but few operate regimes that are more opaque, unaccountable or open to political and bureaucratic manipulation”, the FT said, adding that the Government’s power to block deals or conditionally approve deals on “national interest” grounds relied on “a criterion so vague as to justify almost anything”.

Noting that the OECD had recently urged the Australian Government to accelerate the pace of economic reform, the newspaper concluded that “when Canberra next makes a bonfire of costly, perverse and inefficient regulations, the FIRB regime should be at the top of the pile”.

It is unfortunate that it takes a foreign newspaper to give this process some critical scrutiny. The local press generally view the politicisation of the ownership and control of equity capital as unproblematic. The above extract is taken from Malcolm Maiden, who also feels compelled to offer at least some defence of the indefensible.

Ross Gittins: Conspiracy Theorist

When I wrote in last week’s column that the OECD hadn’t advocated a cut in the top tax rate, I was wrong. It did just that on page 65 of its report, although this proposition didn’t make it into the summary assessment and recommendations. Wonder why.

Woodside Revisited

As in the case of the Shell/Woodside deal, the Treasurer receives no guidance from the law as to what he should consider when weighing the national interest. The Foreign Investment Review Board will offer advice based on its interpretation of the act but the Treasurer is free to decide for himself what constitutes the national interest and whether XStrata’s ownership of WMC would compromise it.

Harper explores the contradictory logic employed in both episodes. But the real issue here is not the merits or demerits of foreign ownership in a given case. It is that the ownership and control of equity capital in Australia is subject to sweeping ministerial discretion, not to mention the bureaucratic discretion exercised by the ACCC. The rule of law is almost entirely absent, which encourages rent-seeking behaviour and the misallocation of equity capital.

UPDATE: The Treasurer is being praised for making the ‘right’ decision by not blocking the XStrata bid. Steve Lewis says it is ‘a decision that will enhance Australia’s reputation as a haven for foreign investment,’ and that ‘…the Howard Government has sent another powerful signal that Australia is open for business.’

In fact, the decision sends a signal that any attempt to upset the status quo in relation to the ownership and control of Australian equity capital will have to run the gauntlet of the political process, allowing special interests to seek outcomes they could not otherwise secure in the marketplace. Rather than praising the outcome, we should be damning the process, which has Australia running the fifth most restrictive FDI regime in the OECD.

Capitalist Internationale?

At an Internet café late Thursday night, I am set upon by two Swiss undergrads who earlier in the day had participated in an antiglobalization rally. How, they would like to know, do I justify my presence at this malign gathering of the Capitalist Internationale? O that it were the Capitalist Internationale, I reply. I explain that this year’s Davos is purpose-built to satisfy all of their grievances. They think the Forum’s concern for the poor and the environment is a meaningless gesture at best and probably a devious trick. I think: “The capitalists will sell the rope from which they will hang.”